If you’re considering debt consolidation—the practice of combining multiple debts into one loan—you need to understand the advantages and potential disadvantages beyond cost savings. Consolidation is certainly worth considering to secure better rates and terms if you have multiple loans with high-interest rates and have improved both your personal and business finances.
To understand whether you’re eligible and if it’s the right fit for you, we’ll dig into the definition of small business debt consolidation, how it works, how it differs from refinancing, how to determine if it’s right for you, the two loan types that work best for loan consolidation and the 6 steps you should take to unify your debts.
What Is Business Debt Consolidation?
Consolidating can eliminate many of the monthly payments your business is making and, though it’s not a guaranteed benefit of debt consolidation, potentially reduce the interest rates on that debt.
How a Business Debt Consolidation Loan Works
If your business is struggling to manage the different repayment schedules in your organization, a business debt consolidation loan can bring a great deal of simplicity to your debt management.
In its simplest form, a small business debt consolidation loan takes any applicable accounts and payments and bundles them into a single loan payment.
Consolidating eliminates the need to remember multiple loan payment due dates, with a single, consistent payment.
The Difference Between Business Debt Consolidation and Refinancing
While these two terms are sometimes used interchangeably, they describe two distinct financial actions. While business debt consolidation is a form of refinancing, it’s important to recognize the differences between them.
It’s important to note that debt consolidation doesn’t mean that you will receive a condensed loan with a lower interest rate.
While it would be terrific if your business debt consolidation loan saved you money in interest fees, the primary goal of debt consolidation is to make payments more manageable by eliminating several payments with one. It’s entirely possible that your consolidated interest rate will be similar to your current terms.
How to Know It’s Time for a Small Business Debt Consolidation Loan
Regardless of what your financial picture may have looked like when you first took on business debt, it’s possible that you could now be eligible to secure better rates and terms. If your financials have improved, consolidation is certainly worth considering.
Here are some signals that you may want to consolidate your small business debt:
You Have More Than a Few High-Interest Loans
The higher your current interest rates, the more beneficial it will be for you to pursue small business debt consolidation.
As you’re applying for a new, lower interest rate loan, the same qualification and approval factors that were used to evaluate your business originally will be used again. These include how long you’ve been in business, your personal credit score and your business’s annual revenue.
It only takes one of those factors to have improved to qualify your business for a debt consolidation loan with a lower rate than your current loans.
You Want to Extend a Short-Term Loan
When entrepreneurs take out loans, they do so with the intention of the funds helping the business grow. However, there are moments when owners need a longer time to see a positive return on their investment. A business debt consolidation loan is one way businesses can guarantee themselves more time before having to repay the debt in full.
Make sure that the revenues you’re counting on will be enough to cover the full amount of the loan—including additional interest that will accrue.
Your Personal Credit is Above 620<
For a lender to assist you in debt consolidation, they must first verify that your personal credit is solid. Any interest rates and terms that a lender is ultimately willing to offer is significantly affected by personal credit.
To help you understand your personal credit score and what’s considered good, let’s review the score categories below:
Anything above 700 is seen as an excellent credit score. With a score this high, banks and lenders will be competing to offer your business the lowest interest rate. Owners with scores between 620 and 700 who’ve been in business will also have attractive options to lower their interest rates through consolidation, though it’s likely there won’t be as many suitors involved.
For entrepreneurs with credit scores in the range of 550-620, there’s no guarantee you’ll be able to consolidate at a rate lower than any of your current loans. Finding a consolidation loan that would benefit you would be dependent on finding the right financing partner, as well as having multiple years in business and strong annual revenues.
You’ve Improved Your Business Finances
If your business’s revenue or profitability has improved month-over-month for 3 straight months, your chances of qualifying for a lower consolidation loan increase immensely.
It’s important to note that the minimum business revenue required to consolidate your debt is typically $25,000. Your business’s debt service coverage ratio should be 1.2 at a minimum.
You’ve Improved Your Personal Finances
As we learned with credit scores, personal finances matter a great deal as a small business owner, especially when it comes to consolidating small business loans.
In addition to the pieces we’ve discussed above, qualifying for a business debt consolidation loan means having improved any of the following aspects of your personal finances:
- Increased personal income (via sources other than your business)
- Reduced personal debt
- Lower household spending
- Greater real estate equity
- Fewer dependents
You’ve Been in Business More Than One Year
Whenever you apply for business funding of any kind, the longer you’ve been in business, the more it will help you in securing a business debt consolidation loan with a lower interest rate.
Organizations with longer financial histories have more ways to demonstrate their ability to sustain success and profitability to lenders. Before applying for a business debt consolidation loan, your organization should be in operation for at least one year.
Is a Business Consolidation Loan Right for You?
If you’ve confidently answered, “yes,” to at least 5 of the 6 factors above, getting more favorable rates and terms through a small business consolidation loan is possible.
However, if you were unable to answer affirmatively to the majority of the requirements above, you have a bit more work to do before you can effectively consolidate your business debt. The best way to become eligible is to continue making regular, timely payments on your current loans and do your best to improve your personal credit by limiting purchases while also making routine, monthly payments.
Consolidating Your Business Debt in 6 Steps
Once you’ve determined that you’re a good candidate for debt consolidation, it’s time to move forward. There are 6 essential steps to condensing your debt, starting with what you’re currently responsible for.
1. Understand the Current Terms of Your Debt
Armed with the knowledge of when it’s time to consolidate, the first step involves understanding the type of debt you’re centralizing and the terms it carries.
For example, it’s common to want to consolidate the highest interest rate loans first. While this is understandable, it’s possible that your current loans have restrictions keeping you from consolidating them. Debt holders often forget to include the cost of prepayment penalties or other refinancing costs into their total calculations.
Although consolidating to a cheaper interest rate may look great in theory, in principle, it can be a costly mistake if the unification triggers additional fees or penalties. Being aware of the fine print may seem unimportant when you initially came to terms, but clearly, the language makes a significant difference when you’re consolidating.
2. Weigh Your Potential Options vs. Current Debt
Once you’ve gathered all the details, establish whether consolidating will save you money. Before you can appropriately weigh your options, we recommend that you speak to your CPA to double-check that you haven’t overlooked something in the numbers or the language of your current debt terms.
3. Outline Which Debts to Consolidate
You may be in a position to consolidate some, but not all, of your debt. It’s entirely possible that the rates you have on one loan are far better than the rates you have on another. Regardless, you need to have come up with an approach of how you’re planning to reduce the number of payments and interest rates you currently have. Even if you’re unable to consolidate all of your debts, reducing what you can (as long as its a net positive for your business) is still worthwhile.
4. Determine Your Qualifications
As with any other loan, each lender’s requirements for a debt consolidation loan will vary. However, there are a few universal qualifications that you can be confident in before applying.
These basic elements include:
- At least one year in business
- An annual revenue of $100,000+
- A personal credit score of 600+
- A debt service coverage ratio of 1.2 or better
5. Organize Your Documents
Having the right documentation prepared before applying not only gives you peace of mind, it helps keep the approval process from stalling. For example, traditional SBA loans and SBA express loans can take weeks, even months to be approved. The best way to expedite this process and keep everything on track is to be prepared with the right documentation before applying.
6. Time to Apply
When it’s time to apply, you want to be able to trust the advice your lender shares with you. As important as steps 1 through 5 are, finding the best lending partner for your small business debt consolidation loan is arguably the most critical.
The lender you choose to work with could mean the difference of saving a few months of payments and a few thousand dollars.
Many financing partners simplify the process by offering a streamlined online application that only takes a few minutes to see if you pre-qualify, handling administrative details in the process.
The Two Best Loan Types for Business Debt Consolidation
When you’re looking to reduce your business debt, only a few loan types allow you to consolidate properly. For example, short-term business loans are excellent for small projects and infusions of working capital, but aren’t appropriate for unifying all of your debts into one, simplified payment. In fact, short-term loans are meant to be paid off or refinanced within 18 months.
With this in mind, the main options for entrepreneurs looking to consolidate their business debt are term loans and SBA loans. Below, we break down the requirements and merits of each.
Traditional Term Loans
Typically, a term loan is the best option for businesses looking to consolidate.
Traditional term loans offer the lowest interest rates with the longer repayment terms, averaging 10 percent and 10 years, respectively. Regardless of whether you apply with one of the big, national banks or a local, independent institution, banks will only approve qualified applicants.
In most scenarios, this means that a business has been in operation for one year or more with an annual revenue equal to or greater than $100,000 and a credit score of 600+.
If a business owner is unable to secure a term loan, their next step is to pursue an SBA loan. These programs were designed to decrease the risk for lenders who provide funding to small businesses. SBA loans are intended for owners who may not meet the qualifications of a traditional bank loan but still have strong credit.
One of the most popular programs, an SBA 7(a) loan, offers terms up to 25 years with amounts as high as $5,000,000 and interest rates starting at 6 percent.
Ultimately, if your business is managing multiple debts, it makes sense to consolidate only if you’ll pay the same or less money overall. However, if you need to centralize your debts to improve your operational cash flow, spending a bit more over the long-term might be worth it in your circumstance.
Managing debt is a key element of running a successful operation. While taking on debt can, at times, be the best way for your business to grow, it can also hinder your growth. Keep an eye on your debt-to-income ratios and continue to find ways to reduce your debt. Both of these pieces will help you reach your organizational goals and position you to do more with the revenue you do generate.